Walloped by financial risk

Walloped by financial risk
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First Published: Sun, Aug 03 2008. 10 53 PM IST

Illustration: Jayachandran / Mint
Illustration: Jayachandran / Mint
Updated: Sun, Aug 03 2008. 10 53 PM IST
The list of companies reporting mark-to-market, or MTM, losses on various financial instruments keeps growing. It is clear that many firms misread the direction of interest rates and currencies, especially the latter.
Illustration: Jayachandran / Mint
Ranbaxy Laboratories said last week that its MTM losses on foreign exchange derivative contracts were Rs908 crore, which suggests that it has taken very large derivative positions. Its profit for the quarter ended 30 June plunged 91% as a result. Others such as Tata Motors and Mahindra and Mahindra too have booked losses on their financial hedges. A few smaller ones such as outsourcer Firstsource Solutions have slipped into the red because of MTM losses.
There are two sets of issues here. One, while the details of various derivative positions taken by companies are not available, the fact that firms have lost money in unison suggests that the corporate sector as a whole has taken similar bets. In fact, it is not the losses per se but the way they are clustered that is the real cause for worry. This looks like herd behaviour rather than sophisticated risk management.
The second set of issues is related to currency policies. The Reserve Bank of India (RBI) intervenes heavily in the foreign exchange market to control the movement of the rupee. RBI’s official line is that it does not target any particular exchange rate; it only worries about extra volatility that could unsettle the market. So it tries to dampen volatility through its intervention.
But the way the rupee has moved in the past couple of years — a seemingly inexorable rise and then a sudden drop that many now believe will continue — encourages firms to take one-way bets on its movement. That is not healthy. A two-way movement in the rupee will keep them on their toes.
It is very likely that most of the firms which bought forex derivatives or hold foreign debt on their balance sheets were expecting the rupee to keep rising against the dollar. Instead, it suddenly reversed course in the third week of April, as the trade deficit widened and foreign investors pulled money out of the stock market. It’s no wonder MTM losses have piled up in the April-June quarter.
MTM losses are not cash losses. They may be recouped if the rupee changes course. But their sheer size suggests that companies have to take a hard look at risk management and the central bank has to be less intolerant of two-way moves in the rupee.
Have companies failed to manage financial risk? Write to us at views@livemint.com
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First Published: Sun, Aug 03 2008. 10 53 PM IST